Black Gold, Red Balance Sheet

By Roger Carlile

March 15, 2015

The increasing impact of depressed oil prices and its implications for global economies, the industry and its constituents has dominated the news cycle. As the geopolitics of oil play out, the post-financial crisis industry boom is looking increasingly like an unfulfilled dream as a result of the broad sweeping business implications the current cycle will have. In the first of a two-part series on the oil industry, Ankura Consulting Group will examine the core sector dynamics and how companies can best prepare themselves.

The industry majors are pulling back from mega projects, many of which are significantly behind schedule or over budget given the technological difficulty, inaccessibility of projects and/or higher price assumptions needed to support the business case for asset development. These combined factors have driven soaring capital expenditures even as production has slowed. In addition, availability of oilfield equipment and services has continued to contribute to enhanced development costs, further impacting upstream capital efficiency. Demand from investors for reductions in capital spending and more effective deployment have been met with announced divestiture programs of non-core assets.

The independents however are already seeing the pitfalls of the industry-wide weak balance sheets and operational over-extension. Leverage of independents has almost doubled since 2009, with the total debt of U.S.-listed independents now near $260 billion [Bloomberg]. Companies with productive shale assets remain extremely profitable given the low operating costs, however the unfortunate fact remains that even productive assets experience output declines of 60% and upwards in their first year. Some institutional equity investors have already voted with their feet given the intensified focus on returns and the need for deployment of assets to the most efficient shale plays to combat the sustained price environment. This has already resulted in a substantial reduction in the U.S. rig count year-over-year, a significant decline in domestic production and a wave of redundancies already beginning to impact communities dependent upon the industry for their livelihood.

The industry is divided over the “minimum” oil price. While ongoing shale programs are viable, the broadly held wisdom that the lower cost of shale gas production will enable it to withstand protracted periods of price depression is coming increasingly under fire. It would seem clear that an increase in sector bond yields and a broader debt market constriction amid a backdrop of falling production will inevitably lead to the most feared gulf, that of funding.

There will be winners and there will be losers. Those companies with greater liquidity or access to liquidity may weather the storm. Those without could be subject to continued speculative M&A activity from the private sector on the hunt for distressed assets or alternatively may need to commit to orderly restructurings to avoid bankruptcy proceedings.

In these moments of significant corporate distress, companies need to engage trusted counsel that can be a source of strength and security in times of rapid change and risk potentially affecting enterprise value. When working with our clients, Ankura Consulting Group’s objective is to provide a broad range of restructuring, bankruptcy and insolvency expert services that allow for the successful completion of a case. Our combined experience in many multi-faceted situations enable us to bring perspective, offer objective counsel and undertake the necessary analysis to assist our clients in achieving their objectives.